Pengyuan International Assigns 'A' Rating to China Baowu Steel Group
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Corporate China Pengyuan International Assigns ‘A’ Rating to China Baowu Steel Group; Outlook Stable Ratings Overview Issuer Rating ▪ Pengyuan International has assigned a first-time global scale long-term issuer LT Issuer Credit Rating A credit rating (LTICR) of ‘A’ to China Baowu Steel Group Limited (Baowu). The outlook is stable. Outlook Stable ▪ Baowu’s issuer credit rating is based on a ‘bbb-’ standalone credit profile (SACP) and our assessment that the central government has very strong willingness to support the Company in the event of a financial distress. ▪ The stand-alone credit profile (SACP) of Baowu is supported by its leading Contents market position and large operating scale in global steel industry, and is constrained by its relatively high leverage and shrinking profit margins caused Key Rating Drivers ........................ 2 by the overcapacity and weakening demand of steel product in the long run. Business Profile ............................ 3 Rating Outlook Financial Profile ............................ 5 Government Support .................... 6 ▪ The stable outlook reflects our expectation that Baowu will be able to maintain its operation amid the recovery of China’s economy and the Chinese central Liquidity......................................... 6 government will continue to support the Company in the event of distress. Company Background .................. 6 ▪ We would consider a rating downgrade if 1) substantial evidence shows that Peer comparison ........................... 7 the central government’s willingness to support the Company weakens in the event of distress; 2) we downgrade our sovereign credit rating on China. Rating Scores Summary ............... 8 ▪ We would consider a rating upgrade if 1) there is further backing from the Related Criteria ............................. 8 government to support the Company; 2) we upgrade our sovereign credit rating on China. Financial Summary Table 1: Financial Ratios 2018A 2019A 2020F 2021F 2022F Contacts Debt/EBITDA 1.8x 2.7x 3.3x 2.7x 2.5x EBITDA Interest Coverage 8.1x 6.5x 6.6x 7.1x 7.4x Primary Analyst Gross Debt/Capitalisation 34.2% 34.4% 37.7% 36.2% 34.6% FFO/Debt 48.6% 32.1% 23.1% 28.4% 30.6% Name Winnie Guo OCF/Debt 39.4% 10.6% 2.5% 21.7% 12.2% Title Director Direct +852 3615 8344 FCF/Debt 24.7% -12.1% -16.3% 0.9% -2.5% Email [email protected] EBITDA Margin 15.9% 10.8% 10.5% 11.3% 11.0% Secondary Analyst ROIC 15.5% 12.3% 9.2% 9.6% 9.5% Source: Company, Pengyuan International estimates Name Leon Li Title Analyst Direct +86 755 2348 3867 Email [email protected] 2 December 2020 Page | 1 RA02050200006 Corporate China Key Rating Drivers Credit Strengths Strong external support from the SASAC. Baowu is 90% held by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). The Chinese government controls the board and senior management appointment. Hence, the Chinese government has a strong influence over Baowu’s long-term strategies. Baowu has taken the lead in restructuring China’s steel industry and implemented the supply-side reforms as instructed by the government. A number of Baowu’s mergers and acquisitions of China’s steel industry players were done through stake transfers approved by the SASAC, demonstrating the government’s support to the Company. The Company has successfully acquired Magang Group (Magang) in 2019 and Taiyuan Iron & Steel Group (TISCO) in 2020. Global leader in steel production industry. After consolidating with TISCO, Baowu became the largest steel producer in the world in terms of crude steel production. The Company was ranked 111th by Fortune on the Top500 list. Baowu reported 95 million tonnes of crude steel production in 2019. Its crude steel production capacity will reach over 100 million tonnes after its takeover of TISCO. Benefiting from the acquisitions and consolidations, Baowu will be able to increase its market shares, strengthen its bargaining power and enlarge its economies of scale. Dominant position in steel market. Owning dominant market shares in the subdivided steel markets, Baowu is the largest and the third largest provider in silicon steel and auto-sheet in the world, measured by the sales volume. The Company has a diversified product line, specialising in producing high quality and high value-added steel products. The acquisitions of Magang and TISCO have enabled the Company to further enhance its market position in wheel tire, H-shaped steel products and stainless-steel products. Benefiting from its market position and strong technical expertise, the Company has established long-term strategic relationship with its customers, most of whom are industry leaders in different manufacturing sectors in China. Financial profile to improve. We expect Baowu to lower its leverage in 2021 and 2022, driven by a solid growth in EBITDA and disciplined capital expenditure. Steel prices have picked up since May 2020, driven by the revival of industrial production in China. We expect China's steel demand to further pick up in 2021 amid favourable government policies towards the downstream industries such as construction, infrastructure and automobile. As a result, we expect Baowu to maintain an around 10% EBITDA margin in 2021 and 2022. In addition, we expect the Company’s adjusted debt to decline on a medium- term normalised capital expenditure basis. Credit Weaknesses Business concentration risk. Despite a diversified product portfolio, Baowu has a majority of its revenue generated from the steel industry. As a result, the Company’s profitability has a high exposure to the cyclicality and the risk of the steel industry. Risk associated with mergers and acquisitions. Baowu has been active in the mergers and acquisitions in the recent years. Though we see opportunities and benefits, the mergers and acquisitions increased the operating risks, as synergies generated may not be as significant as the Company has expected. 2 December 2020 Page | 2 RA02050200006 Corporate China Table 2: Key Credit Metrics (RMB million) 2018A 2019A 2020F 2021F 2022F Financials and Profitability Revenue 530,019 552,206 649,454 692,837 730,948 EBITDA 84,306 59,430 68,254 78,296 80,164 EBITDA margin 15.9% 10.8% 10.5% 11.3% 11.0% Return on assets (ROA) 6.4% 5.2% 4.5% 4.9% 4.9% Return on invested capital (ROIC) 15.5% 12.3% 9.2% 9.6% 9.5% Cash Flow Measures Funds from operations (FFO) 74,365 52,082 52,658 60,388 62,205 Operating cash flows (OCF) 60,334 17,232 5,711 46,198 24,867 Free cash flow (FCF) 37,758 -19,628 -37,186 2,016 -5,026 Discretionary cash flow (DCF) 29,422 -27,303 -43,521 -5,489 -12,324 Capital expenditure 22,576 36,861 42,897 44,182 29,893 Balance Sheet Measures Cash and liquid investments 83,336 108,173 128,311 141,715 149,606 Excess cash 50,409 55,693 70,366 82,699 89,529 Total debt 203,374 218,137 298,546 295,546 292,546 Adjusted debt 152,965 162,444 228,180 212,847 203,017 Total capitalization 594,566 633,529 791,213 817,076 845,010 Leverage Measures Debt/EBITDA 1.8x 2.7x 3.3x 2.7x 2.5x EBITDA/Interest expense 8.1x 6.5x 6.6x 7.2x 7.4x Gross debt/Capitalization 34.2% 34.4% 37.7% 36.2% 34.6% OCF/Debt 39.4% 10.6% 2.5% 21.7% 12.2% FCF/Debt 24.7% -12.1% -16.3% 0.9% -2.5% FFO/Debt 48.6% 32.1% 23.1% 28.4% 30.6% DCF/Debt 19.2% -16.8% -19.1% -2.6% -6.1% Debt/Equity 39.1% 39.1% 46.3% 40.8% 36.7% FFO/Cash interest expense 7.1x 6.9x 5.1x 5.5x 5.8x * EBITDA and EBITDA margin include cash dividends from equity investment Source: Company, Pengyuan International estimates Business Profile Global leader in steel production industry Baowu was formed through the merger between Baosteel and Wuhan Iron & Steel in 2016. Since then, Baowu has become the largest in China and the second largest steel production company worldwide, in terms of crude steel production. In 2019, Baowu registered 95.47 million tonnes of crude steel production and RMB552.2 billion of revenue. The Company was ranked 111th by Fortune on the Top500 list. In recent years, Baowu has implemented the supply-side reform, running in line with the government’s policy. The Company targets to become a global steel leader with an annual output of 100 million tonnes in the medium term. Baowu’s acquisition of Magang Group Holding Co. in June 2019 is expected to strengthen the Company’s steel production, boosting its output to more than 90 million tonnes. In September 2020, the SASAC of the State Council approved the acquisition of a 51 percent stake in TISCO by Baowu through stake transfer from Shanxi Province State-owned Capital Operation Co., Ltd. Taking into account of TISCO’s 10.86 million tonnes of crude steel production in 2019, the consolidated Baowu crude steel production in 2020 is estimated to reach over 100 million tonnes, outpacing the world’s largest steel-maker ArcelorMittal with 97.31 million tonnes of crude steel production in 2019. An industry-wide restructuring is taking place in China, in anticipation of more merger and acquisition activity to continue at an active pace over the next three to five years. By 2025, the country's top 10 steel enterprises will raise their output to between 60% and 70% of the nation's total, according to the target set by the State Council. In this case, we believe Baowu, a leading steel producer in China, will continue its business expansion via mergers and acquisitions in the next three to five years.